One of the cornerstones of WTO principles is the idea of non-discrimination, a guarantee that any member country’s exporters pay the tariff that is no higher than that facing that of any other member country. But, preferential trade agreements (PTAs) by definition are discriminatory, and WTO rules allow for such an agreement only if it leads to free trade between members of PTAs.

Whether PTAs are good for the world is a moot point (see, for example, a series of articles in the July 1998 issue of the Economic Journal for both sides of the debate), and therefore PTAs can be “stumbling blocks” for the development of a multilateral trading system under the auspices of the WTO. The relative magnitudes of trade diversion vis a vis trade creation depend to a large extent on the level of external tariffs set in PTAs. Of course, the tariff levels set by any country depend a lot on political factors and most governments are lobbied by interest groups. In the case of PTAs, there is an added dimension in this respect. Since policies in one member country can significantly affect nationals of other member nations, one would expect some degree of cross-border lobbying within PTAs.

Schiff and Winters (2003) discuss the case of lobbying in general, and of cross-border lobbying in particular, in the EU. (5)In fact, cross-border lobbying has become widespread in the EU. Organizations such as Eurocommerce, EuroBio (European Association for Bio-industries), and Friends of Europe are extremely active in EU-wide lobbying. The incidence of cross-border lobbying in North-America is even better documented. (6)Gawande et al. (2006) finds that foreign lobbies play an important role in the determination of U.S. tariffs. (7)Stoyanov (2009) finds significant impact of foreign lobbying on Canadian trade policy, and that foreign firms with preferential market access lobby the Canadian government for more protection. (8)In a similar vein, a lobby firm in the U.S.A. writes on its website, “Holland & Knight’s International Trade Group routinely represents the interests of ... foreign industries before the agencies of the United States Government, ...”.

In many countries, there are limits on lobbying, particularly lobbying in the form of campaign contributions. The restrictions are however much more stringent for cross-border lobbying than for domestic ones. In some countries campaign contributions from foreign sources are completely disallowed. However, there are many ways foreign lobby groups circumvent legislations. For example, during recent congressional and senate elections in the US, newspaper reports suggested that some domestic organizations which do not require their accounts to be made public but which actively lobby politicians were allegedly receiving funds from interest groups overseas.

If lobbying - domestic or cross-border – increases the level of external tariffs, the benefits of PTAs can be greatly undermined, and the WTO will need to review its rules on PTAs and bring issues related to cross-border lobbying into the discussions.

In fact, the effect of cross-border lobbying can be a lot worse if such lobbying also has a positive effect on the level of domestic lobbying. In a recent paper, (9)we examine this issue in the case of both Customs Union (CU) (where there is a common external tariff) and Free Trade Area (FTA) (where member countries set their own external tariffs). In our model, there are two member countries and the rest of the world. For a CU, we find that cross border lobbying increases the equilibrium value of the common external tariff directly, as well as indirectly, via an induced rise in the levels of domestic lobbying. Cross-border lobbying, for given levels of domestic lobbying, increases the optimal value of the common external tariff. In turn, this increases the marginal profits of domestic firms, and thus the marginal benefits of domestic lobbying, resulting in higher equilibrium levels of the latter.

As for an FTA, we first show that the indirect effect of cross-border lobbying on external tariffs can either be positive or negative, depending on whether tariffs in the two countries are strategic complements or strategic substitutes to each other. Next, we develop a specific oligopolistic model of FTA and find that the tariffs in the two member countries are strategic complements. Thus, we find similar qualitative effects of cross-border lobbying on external tariffs in both CU and FTA, and conclude that the existence of cross-border lobbying weakens the case for the existence of PTAs within the broad principles of the WTO.

Note:1. The views expressed are those of the authors and do not necessarily represent official positions of the Federal Reserve Bank of St. Louis or of the Federal Reserve System. back to text2. Federal Reserve Bank of St. Louis, Research Division, PO Box 442, St. Louis, MO 63166, U.S.A.; and Research Fellow at IZA, Bonn, Germany; E-mail: Subhayu.Bandyopadhyay@stls.frb.org. back to text3. Department of Economics, Southern Illinois University Carbondale, Carbondale, IL 62901-4515, U.S.A.; E-mail: lahiri@siu.edu. back to text4. Murus Research, Ballwin, MO 63021, U.S.A.; E-mail: wall@murusresearch.com. back to text5. Schiff, M. and L.A. Winters, 2003, Regional Integration and Development, World Bank, Oxford University Press. back to text6. Quite detailed data in the U.S.A on lobbying firms, amount spent, and their clients can be found at www.opensecret.org. back to text7. Gawande, K., P. Krishna and M. Robbins, 2006, Foreign Lobbies and US Trade Policy, Review of Economics and Statistics, 88, 563-71. back to text8. Stoyanov, A., 2009, Trade policy of a free trade agreement in the presence of foreign lobbying, Journal of International Economics, 77, 37-49. back to text9. “Cross-Border Lobbying in Preferential Trading Agreements: Implications for External Tariffs,”Federal Reserve Bank of St. Louis Working Paper 2009-041A. back to text

Subhayu Bandyopadhyay, Subhayu Bandyopadhyay is a Research Officer in the Federal Reserve Bank of St. Louis, and a Research Fellow at IZA, Bonn. His recent contributions are in the areas of international trade and development, and the economics of terrorism.

Sajal Lahiri, PhD from the Indian Statistical Institute (1977); worked at the University of Essex (1978-2002); since 2002 holds an endowed chair at the Southern Illinois University Carbondale.
Written extensively on issues related to international and development economics; was a member of the Restrictive Practices Court in the UK to hear a case on Retail Price Maintenance involving medicaments.

Howard J. Wall, Howard J. Wall is the Principal Economist for Murus Research, which he founded in November 2010. He has extensive experience in academia and central banking, most recently as vice president and regional economics adviser at the Federal Reserve Bank of St. Louis. Prior to joining the St. Louis Fed, he spent ten years as an academic in the economics departments at West Virginia University and Birkbeck College, University of London.